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Mergers and Acquisitions in Canada

A plan of arrangement is a multi-step transaction which may involve an amalgamation, an amendment to the corporation’s articles, a transfer of property, an exchange of securities, a compromise with creditors or any combination of the above. The principal disclosure document is the information circular which is mailed to the target’s security holders in respect of the meeting called to approve the arrangement.

A plan of arrangement involves two court appearances and a shareholders meeting. At the first court appearance, the parties request an interim order which provides for the calling of a special meeting of shareholders and sets out procedural matters, such as the determination of the classes which have the right to vote separately as a class and the percentage of approval required. The court will also ensure that shareholders are granted a dissent and appraisal right similar to the one they would have received if the corporation had proposed an amalgamation. At the second court appearance, which occurs after the shareholders meeting, the court is asked to issue a final order approving the plan of arrangement. Shareholders who object to the granting of the order may attend and present evidence at this hearing. In determining whether to grant the requested order, the court will consider whether the plan is “fair” to the shareholders. The court may approve the arrangement as proposed or as amended by the court. The plan of arrangement becomes effective once the necessary documents, which include the final order, are filed with the applicable corporate registry and, in certain circumstances, a certificate is issued by the corporate registrar.

Subsection 3(a)(10) of the U.S. Securities Act of 1933 (the “1933 Act”) provides an exemption from the registration requirement for the issuance of securities (if the issuance has been approved by a court of competent jurisdiction after a hearing on the fairness of the terms and conditions of issuance, of which all holders of the target’s securities receive notice, and have an opportunity to attend and be heard). Canadian plans of arrangement have been expressly recognized by the SEC as satisfying the requirements of ss. 3(a)(10). As a result, the plan of arrangement is often used if a Canadian target has a significant number of U.S. shareholders, since it enables the buyer to issue its securities to the shareholders of the target pursuant to the plan of arrangement, without prior SEC review. In addition, Canadian foreign private issuers are exempt from the SEC proxy rules. Therefore, if a U.S. buyer’s shareholders are not required to vote on the transaction, the SEC proxy rules will also not apply.

Depending on the issuer’s jurisdiction of incorporation, an issuer proposing a plan of arrangement may be required to demonstrate to the court that it is “not practicable” to effect the proposal under any other provision of the incorporating statute. Where the proposed arrangement has consisted of nothing more than a share exchange or amalgamation, issuers have convinced Canadian courts that the inability to rely on ss. 3(a)(10) of the 1933 Act, with the resulting expense and time delay required to clear a registration statement, makes the other provisions of the incorporating statute “not practicable.”

Advantages and Disadvantages

A plan of arrangement has a number of advantages. Firstly, it offers maximum structuring flexibility and may accommodate the needs of numerous classes of security holders. Another major advantage is that the offeror may acquire 100 percent of the target upon obtaining the approval of only two-thirds of the votes of each class of securities that are entitled to be voted at the meeting. Accordingly, there is no need for a “second step” transaction. Thirdly, the information circular with respect to the meeting does not generally need to be translated into French. Finally, most of the restrictive take-over bid rules, including the pre-integration rules and the collateral benefit rules, do not apply to a plan of arrangement (although persons receiving collateral benefits may, depending on the circumstances, be precluded from voting in a “minority approval” vote that securities regulations may require).

Disadvantages of the arrangement structure include the longer time frame (usually 60 days or longer if an exchangeable share structure is used) and the increased cost. In addition, even if the transaction is approved by the required percentage of shareholders, there is no guarantee that the transaction will be approved by the court, since a shareholder may appear before the court and argue that the transaction is not fair. Finally, a plan of arrangement may only generally be used in a friendly situation.

In a plan of arrangement, the terms of the transaction are normally negotiated between management of the target company and the buyer, and are set out in an acquisition or pre-acquisition agreement. This agreement is the contract that sets out the ground rules under which the transaction is proposed to be completed. The agreement sets out such matters as the consideration to be offered, the conditions precedent to the arrangement, and the representations and warranties of the target. The agreement will also deal with any existing shareholder rights plan. Perhaps the most contentious parts of the agreement relate to the scope of the “no shop” clause, the existence and amount of any break fees, and the terms of any required lock-up agreements from management.

When shares of a buyer form all or part of the consideration, the plan of arrangement is often structured as a three-cornered amalgamation in which the target company amalgamates with a subsidiary of the buyer (which has been incorporated for this purpose), pursuant to which the shareholders of the target receive shares of the buyer. This structure alleviates the need for the buyer to obtain the approval of its shareholders, provided that this approval is not required by a stock market on which the buyer’s securities are listed. (For example, certain stock markets in the U.S. require shareholder approval if a listed company proposes to issue a number of shares exceeding 20% of its outstanding shares in an acquisition transaction, including a plan of arrangement.)

Exchangeable Share Transactions

Exchangeable share transactions are used commonly in plans of arrangement involving a Canadian target and a foreign buyer. The purpose of this structure is to provide Canadian resident shareholders of the target with a tax-deferred rollover on the exchange of their shares of the target company, for shares of a Canadian acquisition company that are exchangeable at the holder’s option for common stock of the foreign public parent. The target’s outstanding options are also usually replaced pursuant to the arrangement, with replacement options exercisable into exchangeable shares. In this structure, the shareholder’s capital gain is deferred until the shareholder sells the exchangeable shares or exercises the exchange right, and acquires the publicly traded shares of the foreign parent company. In addition, the Canadian shareholder will receive the Canadian dividend tax credit on any dividends declared on the exchangeable shares. Exchangeable shares are normally subject to a forced exchange after a certain period of time (usually 5-10 years).

Exchangeable shares are structured to be, in essence, the economic equivalent of the foreign parent issuer’s common stock. The exchangeable shares carry a right to receive dividends on a per-share-equivalent basis in amounts (or property in the case of non-cash dividends) which are the same as, and which are payable at the same time as, dividends declared on the buyer’s common stock. The exchangeable shares carry a right to vote on a per-share-equivalent basis at all shareholder meetings, at which holders of the buyer’s common shares are entitled to vote, usually through the medium of a special voting share in the capital of the buyer, carrying votes equal to the number of outstanding exchangeable shares. Exchangeable shares also carry the right to participate on a per-share-equivalent basis to that of the buyer’s common stock in a liquidation, dissolution or other winding up of the buyer, or distribution of any assets of the buyer.

The terms of the exchangeable shares are established through a combination of documents, including the share provisions, a support agreement which provides covenants of the buyer to provide the necessary financial support to allow the Canadian subsidiary to declare dividends equivalent to those declared by the buyer, and a voting and exchange trust agreement which provides covenants of the buyer concerning the voting and exchange mechanics.

Exchangeable share transactions are usually done through a plan of arrangement and follow one of the following structures:

  1. 1.     the buyer organizes a Canadian subsidiary and the Canadian shareholders exchange their shares in the target company for exchangeable shares of the foreign buyer’s Canadian subsidiary;
  1. 2.     a three-cornered amalgamation in which the target company amalgamates with a subsidiary of a foreign buyer that has been incorporated for this purpose, pursuant to which the shareholders resident in Canada receive exchangeable shares of the amalgamated company which are exchangeable into shares of the buyer; or
  1. 3.     the target company undergoes a capital reorganization in which the common shares of the target company are converted into exchangeable shares of the target company.

The buyer may need shareholder approval to create a new class of shares, since in many exchangeable share transactions, a single “special voting share” is issued to the trustee and the voting rights of the holders of exchangeable shares are exercised through that special voting share.

Exchangeable shares issued in an arrangement involving a U.S. buyer are freely transferable under U.S. federal securities laws, except exchangeable shares which are held by persons who are deemed to be “affiliates” (as defined in the 1933 Act) of the target and buyer prior to the transaction, which shares may be resold by them only in transactions permitted by the resale provisions of Rule 145 under the 1933 Act, or as otherwise permitted under the 1933 Act. The buyer will file a registration statement prior to the effective time of the arrangement in order to register under the 1933 Act the issuance, from time to time, of the foreign parent’s common shares in exchange for the exchangeable shares. It is often a condition for completion of the arrangement that the registration statement be declared effective by the SEC. The buyer also usually agrees to file a registration statement in order to register under the 1933 Act the issuance of its common shares, from time to time, after the effective date of the arrangement upon the exercise of any replacement options issued to replace the options of the target.

When a Canadian reporting issuer amalgamates with another company, the amalgamated company automatically becomes a reporting issuer in the same Canadian jurisdictions. The shares issued pursuant to the amalgamation are freely tradable if any amalgamating company has been a Canadian reporting issuer for at least four months. The result is similar in the case of an arrangement. For exchangeable shares, there is an exemption that relieves the issuer of the exchangeable shares from the continuous reporting requirements that normally apply to reporting issuers under Canadian securities laws. The exemption is subject to conditions relating to the dissemination of information regarding the foreign parent company. The effect of those conditions is to provide the holders of exchangeable shares with annual and interim consolidated financial statements, and other information regarding the foreign parent company, in lieu of financial statements and continuous disclosure documents of the issuer of the exchangeable shares.

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